Q&A Forum

tracking costs to compare to budgets

I'm having a great deal of trouble with associating costs with specific jobs. Direct costs are fairly easy, but most of my costs are indirect and some of them are causing headhaches. For example, an employee might requisition 5 gallons of a cleaning agent that is combined in a tank with water for the day and clean 8 orders using it (dip operation). I can't really figure out how much cleaning agent to associate with each of the 8 orders. The parts vary in size and quantity. However, I cannot associate all the cost with, say, the first part run because that loads it with cost. On the other hand, leaving it to Overhead results in a lack of monitoring that results in drastic over usage. I need to be able to track the cost per part number. Has anyone experienced anything similar and what was done about it?

Matthew
Can you try using a standard allocation model to apply a certain charge to each job for consumables/general supplies? This model can help manage the usage more as a direct cost.

Example: establish with your operations colleagues how consumables are normally consumed; gather metrics on the ratio of each consumable/group of consumables as a % of direct costs, or type of job or number of technician hours). Assume after this study you can set a standard of $50 per job (or $50 for job type A and $75 for job type B).
Then, using your GL accounts, for each job that is completed, generate journal entries that debit the job/COGs account with $50 and credit your expense account for supplies. Monitor the net balance on the expense account-it should have a small net debit balance if your standards are reasonable.

Note: this approach assumes your consumables are just that and that you are not trying to manage them as inventory.

Don't forget to integrate these financial controls with operational controls over the consumables so that someone monitors physical consumption.

I agree with Len; create a standard allocation. To firm up the numbers I suggest rolling out a test to start over a month using the new method. .625 gal (5 gal / 8 jobs) allocated to each job. See if this holds up over the test period and then revise accordingly. Once you have a set number in place, you can then analyze for both price and volume variances, truing up monthly/quarterly, etc. Depending on the amount of manufacturing activities and the amount of such consumable product you carry for the process, you may want to put these costs into inventory first; check your materiality.

In general, I'm not a fan of crediting expenses items on the P&L. Auditors hate seeing that too, as well as volumes of journal entries tied to particular transactions. Better to find a way to incorporate such into a COGS charge at the time of sale, using a standard allocation.

I like that idea. Our unique issue is that we work more in small batches with lots of different part numbers rather than a few part numbers with large quantities. These parts change drastically in size and shape. I'm thinking, though, that an allocation model based off of square inches per part may give me what I'm searching for. Instead of reaching a standard number to apply to each job, I may be able to figure out each part's consumption of indirect materials based off its size and quantity as a percentage and apply that from the days total cost.
For example, 5 gal over 8 jobs where the the first two jobs were 500 sq.in and had 10 pieces in each job and the last 6 were 100 sq. in and had 200 parts in each job. The total square inches cleaned would be 130,000. Job 1 was 5000 sq.in. Therefore, it would receive roughly 4% of the day's cost. Job 3, on the other hand, would receive about 15%.
In theory, if I knew the total chemical consumed for the day and the quantity and square inches of each part I SHOULD be able to accurately report how much cost went with each part number. Does that sound like accurate?

Matthew- your thoughts about potentially different models for allocation are good. A few notes
Question : will you be able to reasonably collect data at the day/job/part level in your example to be able to allocate costs? Or will that be too intense in terms of effort and risky in terms of accuracy?
Question: is there a linear/proportional relationship between #parts/sq in and the amount of materials consumed? Or, use some type of grouping to represent likely levels of consumption.
If not, would using various job sizes and a standard for each job size (over the accounting period) serve as a reasonable solution? E.g. Job type 1= up to 10000 sq in; job type 2 = 10001 to 25000 sq in. etc. Then establish a recovery rate per type.

Don't forget to set some baseline measurement today and then track progress. E.g. today we have 12345 jobs, that use 54321 parts and we spend $98765 on cleaning materials/supplies.

The one thing I would add is the true up. You could treat field employee trucks / vehicles like a petty cash account (fixed level inventory) - and then inventory the truck occasionally. The true up would be the offset to the usage - unless you track actual inventory pulls daily.

Any variance between allocated usage and inventory would be put to variance.

What is the activity that will make that cost go away? You need to think about that. If not, you will create the infamous "death spiral" where the same cost keeps getting allocated to a smaller and smaller amount of activity.

While allocating a certain amount (standard cost) of each consumable item to a job or item being manufactured is one approach, I have found, though experience working with many manufacturing companies that making such consumables participate in the full absorption of all manufacturing / factory overhead is a preferred methods and allows you to:

1) Comply with GAAP requirements of full absorption accounting.
2) Provide a more accurate way to determine your cost of goods sold

The simplest way to accomplish this is to post all consumable expenses to specific applied overhead accounts, where other allocated general overhead (e.g., rent, utilities, etc.) are also posted. When you analyze all your applied costs vs. productive direct hours in a given accounting period (e.g., quarter) you will arrive at a pre-determined hourly rate for all such overhead. Added to all direct costs (also as an hourly rate), each job will accumulate the cost of:

1) Direct Material
2) Direct Labor
3) Absorbed overhead

When inventory is completed, everything accumulated in the Inventory WIP will be moved to Finished Goods inventory and expensed to Cost of Goods Sold upon sale of item.

The secret is to accurately perform this analysis. I usually do it once or twice a year using the previous 12 (or 6) months’ data. The calculated direct labor hourly rate and applied overhead hourly rate are reflections of the rates in the analysis period and are used as pre-determined rates for the following period. Actual applied expenses in the following period (e.g., 12 months) will always be different than what is assumed based on the analysis of the previous period, but generally should be fairly accurate if your expenses and product output are fairly stable. The periodic analysis will allow you to adjust your rates and make your cost of goods sold (and inventory valuation) more accurate.

Using a standard allocation can give you an idea (or perhaps set a budget amount) how much of that consumable is expected to be used on a specific job, but may not contribute to the accuracy of automatically performing cost accounting using the full absorption principal. The same it true for other “consumable” items such as heat cost, power, water, etc., that is typically not allocated to a specific product or job, but is indirectly absorbed into inventory using the method described above.

This system is surprisingly simple to set up and monitor and does not require any specific software you probably don’t already use. It works well for job shops and manufacturers with small (and varying) production batches and will actually automate your cost accounting and provide good internal and external financial reporting.

Business Exchange

Contribute to Community

If you’re interested in learning more about contributing to your Proformative community, we have many ways for you to get involved. Please email content@proformative.com to learn more about becoming a speaker or contributing to the blogs/Q&A Forum.